A practical sensitivity model to evaluate cash flows and fields on a proposed cape town property development

Abstract:

The report discusses the development of a "practical computer programme" which enables the sensitivity of yields and cash flows to be determined. The programme is then applied to a proposed major high-rise, property development in Cape Town. The yields and cash flows in the programme are analysed with respect to variations in the critical value inputs. Typical critical value inputs are rates of inflation, rental escalation and finance rates. The effects that inflation, and other economic variables, have on property valuation form an important subsection of the report. It is believed that inflation is one of the most critical, yet neglected, factors influencing property valuation at present. For this reason, the report places an emphasis on inflation. Embodied in this report is a section which deals with the meaning of YIELD frequently used by the property developers. It is proved algebraically that this YIELD REPRESENTS THE REAL RATE OF RETURN as opposed to the commonly accepted monetary rate. The major assumption in the proof is that for a property with no real growth, the long term rental escalation is in line with inflation. The writer believes this concept to be extremely relevant to an investor. An understanding of this concept should enable an investor to make a more realistic appraisal and comparison of the various investment alternatives, which include property, mortgage participation bonds and gilt-edge securities. The report then deals with the workings of the simulation programmes. It also deals with the application of these programmes to a proposed major high-rise property development in Cape Town. Included in the report is an explanation of the various formulae used together with a presentation and discussion of the flow charts and printouts. A typical result from the analysis would be that at a FINANCE RATE of 81%, it would be necessary to escalate RENTALS by at least 4 1% per annum in order to achieve a YIELD of 10%. Other results facilitate a plot of the CASH FLOW profiles during the construction period using FINANCE RATES and RENTAL ESCALATIONS as the parameters. The overall emphasis in this report is placed on the quantitative aspects of property valuation. Relevant conclusions from the report fall into two major categories. Firstly, that property can he more meaningfully and accurately valued through the use of a computer programme using simulation. These programmes are used to present to management, a comprehensive set of figures for a particular development proposal. These figures can be used to facilitate a decision on the viability of a particular proposal. They also present a framework on which to base financial planning.